Reforming International Investment Law: Institutional Change v. System-Internal Adaptation

Stephan Schill, LL.M. (Augsburg) 2002; LL.M. (NYU) 2006; Dr. iur. (Frankfurt) 2008, is Senior Research Fellow at the Max Planck Institute for Comparative Public Law and International Law and Principal Investigator in the ERC project on “Transnational Private-Public Arbitration as Global Regulatory Governance: Charting and Codifying the Lex Mercatoria Publica”.

This is the first in a series of posts on the reform debates in international investment law and investor-state arbitration. These posts are meant both to introduce general international lawyers to a field often still foreign to them and to contribute to the ongoing reform processes as states, supranational organizations like the EU, and international organizations like UNCTAD and OECD are reviewing national and international investment policies. Reforms seem necessary in light of the wide-spread criticism of international investment law and investor-state arbitration. The field is even said to face a “legitimacy crisis” because one-off, party-appointed arbitrators review government conduct in areas sensitive to the public interest in ways that differ significantly from domestic courts. Scrutinizing tobacco labeling legislation in Uruguay and Australia or the German nuclear power phase-out are just two recent examples.

Following Broches: “Procedure before Substance”

Reform proposals abound. Most of them focus on changes to investor-state dispute settlement, not on substantive investment law. Perhaps not surprisingly, reforming often means restricting investor-state arbitration. The recent IIA Issue Note by UNCTAD, “Reform of Investor-State Dispute Settlement: In Search of a Roadmap”, summarizes five paths for reforming investment law:

1) promoting alternative dispute resolution;

2) tailoring the existing system through individual investment agreements;

3) limiting investor access to dispute settlement;

4) introducing an appeals facility; and

5) creating a standing international investment court.

Ironically, stressing institutional reform before addressing questions of substantive investment law follows the same pattern that Aron Broches, then General Counsel of the World Bank, proposed when creating the International Centre for Settlement of Investment Disputes (ICSID), the first standing investor-State arbitration forum, in the 1960s. Seeking to overcome the impasse in finding a global consensus on investment protection in times of decolonization and the Cold War, he championed the formula “procedure before substance”. He meant to create a framework for resolving investor-state disputes that could work out substantive rules on the go. Broches’ formula, which later matured into the ICSID Convention, in a sense, released the spirit of investor-state arbitration that over the years started a life of its own and lead to today’s “legitimacy crisis”. As a cure to this crisis, the five reform paths outlined by UNCTAD keep treading Broches’ track of “procedure before substance.”

Analyzing Investment Law’s Discontent

UNCTAD’s Issue Note does a good job in describing the root causes of the discontents with investment arbitration. It breaks down the legitimacy critique into more specific problems:

1) the vagueness of the governing treaty standards that, coupled with lenient control mechanisms, allow arbitrators to penetrate deeply into scrutinizing domestic policy choices and to favor investment over non-investment concerns;

2) the increasing number of conflicting and inconsistent interpretations by arbitral tribunals and hence the lack of predictability in arbitral decision-making; and

3) the procedural maxims of arbitration understood as a party-owned process, including confidentiality of proceedings, in which non-parties, even if affected, are voiceless.

These points concern legitimacy as policy space, legitimacy as coherence, and legitimacy as participation. They emerge because investment tribunals do not simply function like Montesquieuan bouches de la loi that passively apply pre-existing rules to individual cases; much more, they are active law-makers and act as a mechanism of global governance that may redefine the relationship between private and public interests.

Reversing Broches: “Substance before Procedure”

Yet, I wonder whether isolated institutional reform is the right cure to better protect public interests. Can the same formula (“procedure before substance”) help to remedy the very problems it has contributed to create? Is the restriction of investor-state arbitration really the key to safeguarding the public interest? Or does the problem not continue to lie in the difficulties to form a consensus on substance? While the principles of international investment law are no longer as contested as they were during the New International Economic Order, their application to policy-specific situations, such as tobacco labeling regulation or phasing out nuclear power, remains uncertain. We therefore need to reverse Broches’ formula and seek to clarify substance before making changes to procedure and explore ways to react to the legitimacy crisis within the existing system. In my view, there is great and unused potential in working out ways that investment arbitrators can react to the criticism and adapt their decision-making to better protect public interests within the existing regime of investment law. This may be desirable for a number of reasons.

First, system-internal reform is necessary because institutional reforms to investment arbitration may not be able to address legitimacy concerns any time soon. Indeed, the practical prospects for fundamental institutional change appear remote considering the reluctance of many states to support such reforms. Proposals to create an appeals facility or a permanent investment court so far have not fallen on fertile ground. For example, ICSID’s 2004 proposal to establish an appeals facility failed to gain sufficient support and was shelved. Still, as the List of Contracting States shows, there are many more states joining the ICSID Convention than withdrawing from it. And even if institutional reforms are successful in some parts of the regime, other parts will continue to endorse investor-state arbitration in its present form. Working on arbitrators to reform the regime from within is therefore necessary no matter how some parts of the regime may change.

Second, reforms that merely aim at restricting arbitrator discretion, for example through clarifying treaty standards or arbitral rules, disregard that, no matter how precise applicable standards are drafted, the adjudicatory process always involves a considerable degree of discretion. The right to be treated fairly and equitably may be concretized to mean a prohibition of arbitrary treatment, or the concept of indirect expropriation to mean that except for special circumstances no compensation is due for general regulatory measures. But so defining the standards merely moves the discretion to other issues, e.g., to what conduct is arbitrary instead of what is unfair and inequitable. Building consensus on substance will need to go further than selective change through individual agreements, encompass the whole regime, and be supported by arbitrators.

Third, it is doubtful whether institutional reforms that introduce a more centralized dispute resolution structure (an appeals facility or a permanent investment court) will be able to create more consistency and avoid over-intrusion into governments’ policy space without multilateral rules on substance and without a political organ that can correct dispute resolution decisions that strike the wrong balance between private and public rights. Why should a more centralized dispute settlement system create much fewer inconsistencies than arbitration if the governing law is not multilateralized? And why should we expect a centralized institution to be deferential to governments, when other international adjudicatory bodies, such as the Strasbourg and San José human rights courts, and the WTO Appellate Body do not always exercise deference? Instead, establishing more centralized dispute settlement institutions without multilateralizing substance and without strong multilateral political institutions will likely lead to an even more potent institution than the one Aron Broches envisaged some 50 years ago to get out of the dead-lock in multilateral investment rule-making.

Exploring a Sixth Path of Investment Law Reform

What is then needed, at the very least as a complementary process to institutional reform, are internal approaches that explore how arbitrators can reinterpret the system and react to criticism by changing the ways they settle investor-state disputes, interpret investment treaties, and reason awards. Unlike UNCTAD’s five proposals, such a sixth path of investment law reform could leave untouched the trust investors have developed in international arbitration as an impartial dispute resolution mechanism, while making necessary concessions towards demands of transparency, safeguarding coherence in arbitral jurisprudence and policy space, and paying appropriate regard to non-investment concerns. In the posts to come in this series, I will sketch out and explore such a sixth path for investment law reform that is based on a system-internal reconceptualization of investor-State arbitration as a form of judicial review based on public law.